On the surface, one tobacco company looks just as good as another. They're all working with the same underlying commodity, after all, and they've all been in business long enough to know what their competitors know. Perhaps most importantly, they're all fighting the same smoking-cessation headwind.
Investors weighing a purchase of British American Tobacco (BTI -0.51%) against an investment in Altria Group (MO -0.37%), however, should know there are enough nuanced differences between the two tobacco giants to matter. Altria is the stronger pick of the two, for a handful of reasons.
But first things first.
British American Tobacco vs. Altria vs. tobacco's looming end
At the risk of waxing too philosophically, any investor interested in either of these companies should understand that both are marching toward their eventual end as we know them. The World Health Organization expects the global number of smokers to shrink between now and 2025, finally snapping a multi-decade growth trend and perhaps establishing a new one. In the United States, the National Institute of Health (NIH) and the Centers for Disease Control and Prevention (CDC) also tout the ever-improving success rate of smoking cessation efforts within the U.S.
Recognizing there will likely come a time when tobacco usage simply isn't a thing, both Altria and British American Tobacco are planning for this end. Philip Morris parent Altria is leveraging its rights to market the IQOS tobacco-heating system as part of its "Moving Beyond Smoking" mission, for instance. It's also a stakeholder in Anheuser-Busch and cannabis company Cronos, staking a claim in other kinds of vice industries. Meanwhile, British American Tobacco -- the name behind cigarette brands like Camel, Pall Mall, and Lucky Strike -- is also focused on developing and expanding other product categories like vaping.
The key to continued success, therefore, is cost-effectively managing the paradigm shift underway for the entire tobacco industry. While this is happening, every penny will count. That's why Altria is the healthier pick of the two. It shines more brightly on a couple of important fiscal fronts.
One of these fronts is sheer profitability; Altria turns a great proportion of its revenue into earnings. Over the course of the past 12 months, Altria's operating margin rates and net profit margin rates have both been better than British American's. A little more than 31% of British American's revenue for this timeframe was turned into net earnings, versus 42.6% for Altria. These recent numbers extend long-established trends too. Credit different cost structures and different degrees of pricing power, mostly.
Altria is also servicing less debt, relatively speaking. Whereas British American Tobacco's 37.3 billion pounds' worth of borrowings cost it 921 million pounds in interest expense during the first half of this current year, or 6.8% of revenue, Altria's interest payments this year have only chewed up 4.4% of its year-to-date top lines. In other words, debt is a bigger burden for British American Tobacco than it is for Altria. That's a particular liability right now, in that higher interest rates mean higher interest expenses in the future.
Don't dismiss these seemingly small differences. The nickels and dimes add up, particularly when such a big chunk of your profits are being passed along to shareholders (as is the case for both of these companies).
To this end, perhaps the simplest argument to own Altria shares instead of British American's stock is the bigger dividend. British American Tobacco's current yield of 8.9% is markedly less than Altria's current annualized dividend payment of 9.6% of the stock's price. Given that their continued dividend payments are the only real reason to own either stock (there's no meaningful growth ahead for the tobacco business, while vaping/tobacco-heating products are running into similar headwinds), this slight difference is actually a pretty big deal.
In this case, it is a numbers game
Companies are more than just numbers, of course. There are other, non-quantifiable factors like intellectual property, customer loyalty, and operational proficiency to consider.
It would be naïve, however, to assess either of these two tobacco companies the way you would most other stocks.
See, this is a simple business built around the exact same commodity. And with both organizations being as old as they are, their operations have grown to mirror one another's -- neither has a wildly competitive edge on the other. Besides, the tobacco business is living on borrowed time anyway, and vaping's future already looks rocky as well. Although both British American and Altria can milk what profit opportunity is left for years if not decades to come, again, there's no compelling long-term future growth for either outfit here.
So in this instance, the numbers are what matters most -- and even then they should only matter to investors seeking above-average dividends. You might do almost as well in the long run with a high-yield bond. That choice certainly sidesteps the risk of Altria or British American Tobacco shares slowly losing their value as the tobacco business grinds its way out of existence.
In other words, even if you're planning on stepping into a stake in Altria, keep in mind you're just renting it for its dividend income.
